Reform in South Korea

Brave talk

FINANCE ministers in South Korea once wielded almost unlimited power—and assumed little responsibility. No longer. Kang Kyong Shik, who served as finance minister from March to November last year, was arrested on May 18th for “negligence of duty”, a crime allegedly responsible for bringing the country to the brink of bankruptcy. If convicted, he faces up to three years in prison. But whatever Mr Kang's mistakes in mishandling the financial crisis, his successor appears to be doing not much better.

That became clear on May 20th, when Lee Kyu Sung, the finance minister since February, unveiled plans to clean up Korea's insolvent financial system. His announcement was brave enough: the cost of restructuring must be met primarily by the financial institutions themselves, Mr Lee said, and the government will not step in to keep big companies from going bankrupt. But underneath such rhetoric, business goes on as usual. Last month, under government pressure, troubled SeoulBank lent yet more money to Dong Ah group, South Korea's tenth-biggest conglomerate, or chaebol, at rates hardly justified by the firm's tenuous condition. Last week Dong Ah's construction arm asked for more loans to avert bankruptcy. All indications are that it will get them.

The details of Mr Lee's restructuring plan leave a lot to be desired. The Financial Supervisory Commission, the new banking watchdog, will sort out sick banks from healthy ones by September and may liquidate a couple of merchant banks and stockbrokers. But there is no reason to think that the government is prepared to close commercial banks, no matter how ill they may be. On the contrary, it plans to issue 50 trillion won ($36 billion) of bonds, which will be used to recapitalise the banks and to buy some of their non-performing assets. This means that despite their record of weak management and unwise lending, the banks will all remain in business.

Some 9 trillion won of the bonds will be available to pay off depositors at failed institutions. This money is likely to go to customers of insolvent merchant banks, investment trusts and stock brokerages, whose deposits have all been guaranteed by the government. The banks, however, will be nursed along rather than closed.

In any case, 50 trillion won is not nearly enough to set the financial system to rights. The government estimates that the non-performing assets of Korea's financial institutions will increase from 68 trillion won in March to 100 trillion won by the end of the year. The commercial banks alone have bad loans estimated at 86 trillion won, or three times their combined equity. The government assumes that the banks themselves will be able to sell enough assets to raise the rest of the money required to clean up their balance sheets, but that may be optimistic—particularly because the survival of all of Korea's banks will make it hard for any of them to earn profits.

The shortcomings of Mr Lee's plan do not end there. The government will find it hard to persuade Korean investors to put 50 trillion won into its bonds. It will probably trade the bonds to the bankers it is trying to help, in exchange for some of their bad loans. The bankers will in turn use the bonds as collateral to borrow from the Bank of Korea, the central bank. The central bank will create that money by printing it. The question is whether Mr Lee will be around long enough to deal with the inflationary consequences.